.... when we consider the complexion of the U.S. economy, it makes little sense to focus primarily on manufacturing. Not when the service sector accounts for 80+% of U.S. economic activity and provides better than 80% of all U.S. jobs. When we focus our attention there, suddenly things look pretty darn good and we begin to wonder if the inflation doves aren't missing something.
The breakdown of February's jobs number (reported Friday) nails my point:
Net jobs created in goods-producing industries: 29,000
Net jobs created by Government: 7,000
Net jobs created in service-providing industries: 259,000
And guess how many of the goods-producing jobs were created in the construction industry, 29,000! --- "mostly in the residential component", according to the report (hence my recent commentaries on housing). All other categories were balanced with gains and losses. For example; the 8,000 gain in manufacturing jobs was offset by a loss of 8,000 mining and logging jobs.
The stock market's negative reaction to the jobs number speaks to the last sentence from last week's excerpt above (regarding the service sector): "When we focus our attention there, suddenly things look pretty darn good and we begin to wonder if the inflation doves aren't missing something."
Friday's market sell-off was all about fear over the inflation doves possibly missing something. Or, more accurately at the moment, fear over higher interest rates --- for raising interest rates is the Fed's first line of defense against the threat of rising inflation.
Here again is my graph (click to enlarge) that charts the S&P 500's price to earnings ratio (white line) against U.S. inflation (red line). As you'll see, history suggests that while inflation remains low, valuations can comfortably remain at present levels. Oh but when inflation rises, an altogether different picture develops.
Therefore, if indeed higher interest rates are the antidote to inflation---and if inflation becomes a threat---the Fed raising the fed funds rate is a good thing, not a bad thing, right?
Well, "right", if you're a patient logically-thinking long-term investor. If, however, you're an impatient short-term thinking short-term trader you're thinking about how higher interest rates create competition for stocks. And how higher interest rates mean the cost of capital goes up for businesses (pressuring profits). And when you calculate valuations, a higher discount rate means share prices need to come down if earnings don't happen to accelerate. Actually, if you're a short-term thinker you're thinking other short-term thinkers are thinking what you're thinking and you want to get out before they do.
Investment bliss is NOT being a short-term thinker!
As I ponder all that bears reporting in this weekly missive I realize that should I try to present it all---all with proper explanations---a simple scrolling down the text would send most of my readers' cursors to the X in the upper right corner and off to clean their patios, or to the car wash, or, better yet, the golf course. I know, the text is always huge, but it includes the weekly U.S. highlights from my economic log, which you're okay skipping if that's not your thing.
So here I'll hit the issues and try to keep redundancy to a minimum:
The above and last week's message suffice for now.
Another 10+ million barrels hit the inventory last week. Last week's message tells you what that means.
Per the notes below, Bloomberg's weekly Consumer Comfort Index showed confidence rebounding. The next few weeks will be interesting in that my observation is that the stock market has a major impact on how consumers respond to these surveys.
While "out of the woods" is not how I'd yet characterize Europe, things are clearly looking up. For example: Eurozone retail sales were up 3.7% year-over-year in January, the purchasing managers indexes are coming in above 50 (denotes expansion), and the European Central Bank begins buying 60 billion euros a month worth of bonds on Monday (a plus, at least, for sentiment).
The U.S. Dollar:
Virtually every economist and foreign exchange guru I've listened to of late is certain that the dollar continues its march higher from here. And---while the rest of the world's central banks are taking measures that the textbook says will devalue their currencies, and the Fed ceased quantitative easing last October and is looking to begin raising the fed funds rate, and U.S. interest rates are higher than many foreign equivalents---they're probably right. Which, while a good thing for the U.S. spender and, on balance, the U.S. economy (in that consumer spending is two-thirds of the GDP calculation), it poses a headwind for U.S. exporters---as their goods are more expensive in foreign currency terms.
Like I said, the experts are "probably right". But history doesn't always support the notion that the currencies of the countries whose central banks are easing monetary policy always tank relative to those whose central banks aren't. For example, in 1999 Japan sported the lowest interest rates among the world's major economies---much like the Eurozone does today. Yet, despite that interest rate differential (low yielding yen versus the rest of the developed world), the yen rallied strongly against other currencies. Why? Because the world viewed Japanese stocks as being very cheap and bet that the Bank of Japan's monetary stimulus would work. I.e., global funds found their way to Japan in a big way.
Another similar situation occurred in 2001 on behalf of the U.S. dollar. While the Fed cut interest rates aggressively in response to a slowing economy, rather than sell the low-yielding dollar and buy higher-yielding foreign currencies, the world---thinking that the action of the Fed would result in the U.S. becoming the first major economy to emerge from the global slowdown---rushed to the dollar, pushing it higher despite its globally-low yield.
Could it happen in the Eurozone? Could an improving Eurozone economy spur a rush of investment from the U.S., halting the dollar's advance, if not sparking its decline? Again, the pundits say not this time. But history leaves a little doubt...
The Stock Market:
Here’s a look at the year-to-date results for the major U.S. indices, and non-US indices using index ETFs as our proxies (according to Morningstar and Bloomberg)---as you can see, last week took everything down a peg:
Dow Jones Industrials: +0.68%
S&P 500: +1.00%
NASDAQ Comp: +4.27%
EFA (Europe, Australia and Far East): +4.88%
FEZ (Eurozone): +3.58%
VWO (Emerging Markets): +0.30%
Here’s a look at the year-to-date results for a number of sector ETFs:
IYH (HEATHCARE): +5.23%
XLY (DISCRETIONARY): +4.52%
XLB (MATERIALS): +3.87%
XHB (HOMEBUILDERS): +3.49%
XLK (TECH): +2.52%
XLP (CONS STAPLES): +0.56%
XLI (INDUSTRIALS): -0.21%
XLF (FINANCIALS): -2.02%
IYT (TRANSP): -2.33%
XLE (ENERGY): -3.01%
XLU (UTILITIES): -8.11%
Once again, here's my latest reminder on volatility:
In last weekend’s commentary I attempted to put a rough January into proper perspective by urging you to view the stock market as an “antifragile” (benefits from stress) entity. Again, periodic market downturns are an essential aspect of the long-term investing process. As I stated in our year-end letter, and several commentaries since, I expect financial markets in 2015 to exhibit the kind of volatility that will challenge the resolve of many a short-term investor. Good thing you and I think long-term!
One additional note on volatility: The past couple of weeks I’ve shared with you the very short-term results for markets and sectors. I do this with a bit of hesitation, as I in no way want to give the impression that you, nor I for that matter, should base our long-term investment decisions on short-term movements in markets or their sectors. It can, however, serve as a reference point for how the markets are, or are not, responding to the data (which is why I, as a professional, track the short-term). As you may have noticed, my beginning of the year optimism over non-US and the housing sector (to name two), and pessimism over utilities, appears to be justified by recent results. I need to strongly (very strongly!) emphasize that I was not predicting what we’ve experienced these few short weeks into 2015. My optimism or concerns are based on factors such as valuations, trends, monetary policy and cyclicality—and my comfort in making allocation recommendations rests on the view that our clients are not short-minded investors (it can take awhile, if at all, for the market to reward what I believe to be good fundamental logic) who mistakenly believe that any human being possesses a capacity for market timing. Some people get lucky from time to time, but without exception, market timers are wrong far more often than they are right. The path to long-term investment success is fraught with bumps and potholes. The ones who successfully make the journey take it slow and never over-compensate when steering through and around the inevitable obstacles along the way.
The Bond Market:
The yield on the 10-year treasury bond spiked .25% last week to 2.24%. You can thank Friday's jobs number for that hit to bond prices.
I've been preaching for too long about the present risk to bonds. As Friday illustrated, data pointing to an accelerating economy could turn into a rout in a bond market that I view as bubbly. The next big thing to watch will be the commentary following this month's Fed meeting. If "patient" leaves the narrative, look for bonds to fall further (yields to rise).
Here are last week’s U.S. economic highlights:
MARCH 2, 2015
CORE PERSONAL CONSUMPTION EXPENDITURES (PCE) increased .1% in January, and 1.3% year over year. Inflation reads continue to come in noticeably below the Fed's 2% target.
REAL PERSONAL INCOME grew .3% in January. And 4.6% year-over-year.
CONSUMER SPENDING declined .2% in January. However, the decline was price-related. Price adjusted, personal spending increased .3%.
MARKIT'S MANUFACTURING PMI showed growth hitting a four-month high in February: 55.1, vs 53.9 in January. Here's Markit's chief economist:
“Manufacturing braved the cold weather in February, reporting an upturn in the pace of growth. A flurry of activity towards the month end helped raise production to a greater extent than signalled by the earlier flash reading. The upbeat survey points to minimal impact from the adverse weather that affected many parts of the country during the month.
“While growth of manufacturing output remained below the peaks seen last year, the survey is broadly consistent with production rising at an annualized rate approaching 4%.
“Employment continued to rise, albeit with the rate of job creation slipping as many companies cited increased uncertainty about the outlook, especially with the strong dollar hitting competitiveness.
“Lower oil prices meanwhile once again helped reduce firms’ costs slightly for a second month running, but average selling prices rose at the fastest rate since November, suggesting core inflationary pressures are in fact rising.
“The combination of strong production growth, ongoing job creation and rising factory prices will keep alive the possibility that the Fed could be encouraged to start hiking interest rates as early as June."
CONSTRUCTION SPENDING declined 1.1% in January. Government outlays, dropping 2.6%, lead the way lower. While non-residential construction was down 1.6%, private residential spending rose .6%, after increasing .7% in December, which denotes optimism among home builders.... plus, inventories have been quite low.
THE ISM MANUFACTURING PMI came in a little below expectations, at 52.9, in February. This report is not nearly as optimistic as Markit's survey released today. Many respondents noted the West Coast port strike (now resolved) as having a measurable effect on their businesses.
MARCH 3, 2015
JOHNSON REDBOOK RETAIL REPORTS continues to report surprisingly weak results in my view. Coming in at 2.7% year over year vs 2.8% the week prior. Econoday comments positively on the month over month results and the possibilities for March:
Redbook's same-store sales index came in at a soft plus 2.7 percent in the February 28 week, little changed from 2.8 percent in the prior week. Nevertheless, Redbook's data do point to a 0.8 percent gain vs January in what is a positive indication for February core retail sales (ex-auto ex-gas). For March, Redbook notes that Easter falls two weeks earlier than last year which will move sales into the month at the expense of April.
AUTO SALES came in soft in February, down 2.6% to 16.2 million.
GALLUP'S ECONOMIC CONFIDENCE INDEX came in positive for the second consecutive month, and only the second time in seven years. Although it edged down to 1 from 3 in January.
THE API WEEKLY CRUDE STOCK showed oil inventories rising by 2.9 million barrels last week, with gasoline rising .53 mbs and distillates declining .296 mbs. Tomorrow's EIA number is always the one to watch.
MARCH 4, 2015
THE MBA MORTGAGE PURCHASE APP INDEX continues to show surprising weakness in mortgage activity. The purchase index was down .2% last week, while the refinance index was up 1%. The underlying fundamentals in my view promote optimism on housing going forward. One current hurdle seems to be low inventory. Would-be buyers have little to choose from... Thus, prices have been on the rise of late... which, ultimately, should inspire sellers and builders to bring inventory to the market. All that said, last week's pending home sales report for January showed strength above expectations.
THE ADP EMPLOYMENT REPORT showed 212,000 net new jobs created in February. While it was just off of expectations, 200,000+ is a very healthy number. As I stated last week, we really want to keep our eyes on the service sector, as illustrated in this report with it producing 181,000 of those new jobs. On the goods-producing side, 90% of the jobs were created in construction.
MARKIT'S COMPOSITE PMI for February came in at a very positive 57.1, vs 56.8 in January.
MARKIT'S SERVICES PMI for February came in at 57.1 as well, vs 57.0 in January.
THE ISM SERVICES ("Non-Manufacturing") PMI came in strong at 56.9. The employment component remains a strong contributor, up 5 points to 56.4. As suggested below by ISM's chair, there were some ups and downs in February's survey, but, again, on balance the reading is positive:
"The NMI® registered 56.9 percent in February, 0.2 percentage point higher than the January reading of 56.7 percent. This represents continued growth in the non-manufacturing sector. The Non-Manufacturing Business Activity Index decreased to 59.4 percent, which is 2.1 percentage points lower than the January reading of 61.5 percent, reflecting growth for the 67th consecutive month at a slower rate. The New Orders Index registered 56.7 percent, 2.8 percentage points lower than the reading of 59.5 percent registered in January. The Employment Index increased 4.8 percentage points to 56.4 percent from the January reading of 51.6 percent and indicates growth for the 12th consecutive month. The Prices Index increased 4.2 percentage points from the January reading of 45.5 percent to 49.7 percent, indicating prices contracted in February for the third consecutive month. According to the NMI®, 14 non-manufacturing industries reported growth in February. Comments from respondents have increased in regards to the affects of the reduction in fuel costs and the impact of the West Coast port labor issues on the continuity of supply. Overall, supply managers feel mostly positive about the direction of the economy."
THE EIA CRUDE OIL INVENTORIES REPORT showed that inventories grew yet again last week by a huge 10.3 million barrels. Clearly---as gasoline inventory remained static and distillate inventories delined by 1.7 million barrels---refiners have cut back on production of late.
MARCH 5, 2015
THE CHALLENGER JOB-CUT REPORT is showing layoffs rising this year. February by 50,579, following January's 53,041. The energy sector, which should be no surprise, has been the recent leader in layoffs.
WEEKLY JOBLESS CLAIMS jumped a surprising 7,000, to 320,000, last week. That was 20,000 more than the consensus estimate. The 4-week average is now at 304,750. With surveys showing continued strength in job creation, I expect weekly claims to hang near 300k or below over the intermediate term.
NON-FARM PRODUCTIVITY declined 2.2% in Q4---as hours worked increased 4.9% against output growth of 2.6%. Unit labor costs (1.9% gain in hourly comp plus the 2.2% drop in productivity) increased 4.1% in the quarter, versus a 3.3% estimate. The estimate for Q4 productivity was -2.3%... This is one to watch closely as it is consistent with maturing expansions (as labor costs increase amid a tightening labor market) and ultimately results in higher inflation.
THE BLOOMBERG CONSUMER COMFORT INDEX says consumer confidence grew last week---coming it at 43.5 vs 42.7 the week prior. It's been my observation over the years that consumer confidence correlates closely with the stock market, as Bloomberg suggest below:
Consumer Comfort in U.S. Rises as Stock Prices Reach Records
By Shobhana Chandra
(Bloomberg) -- Consumer confidence in the U.S. rebounded last week from its lowest level of the year as stocks reached record highs, bolstering Americans’ wealth.
The Bloomberg Consumer Comfort Index rose to 43.5 in the period ended March 1 from a reading of 42.7 the prior week that was the lowest this year. Measures of the current state of the economy, personal finances and the buying climate advanced.
The moods of wealthier consumers, who tend to own stocks, rose to a five-week high as the Standard & Poor’s 500 index and the Dow Jones Industrial Average advanced to their highs, the report showed. The best labor market since 1999 and cheaper gasoline also are delivering a boost to household spending, which accounts for about 70 percent of the economy.
The recovery in confidence was “likely in celebration of the stock market’s advances,” said Gary Langer, president of Langer Research Associates LLC in New York, which produces the data for Bloomberg. Among those with annual incomes of more than $100,000, “it’s been higher in this group just twice since October 2007.”
The gauge of Americans’ views on the state of the economy rose to 37.1 last week from 35.7 the previous week. An index of the buying climate, showing whether this is a good time to purchase goods and services, increased to a seven-week high of 39.3, and a measure of personal finances climbed to 54.1 from 53.8.
The S&P 500 rose to fresh records four times in February, and the Dow posted its best month in two years, helping explain why confidence surged among Americans making more than $100,000 a year. The gauge jumped to 69.2 last week, the highest level since the end of January.
Moods worsened for those at the bottom of the wage scale. The comfort gauge for workers earning less than $15,000 a year declined to the lowest since mid-December.
Democratic voters saw an improvement in confidence, with the index increasing to 51.9, the second-highest in 14 years. That compares with 41.3 for Republicans and 38.9 among political independents.
FACTORY ORDERS declined by .2% in February. Non-durables, influenced by energy, fell 3.1%. Durables increased by 2.8%. Leading durables was a big gain in commercial aircraft, 9.7%.
NAT GAS INVENTORIES declined 228 billion cubic feet last week.
THE FED BALANCE SHEET inched up by $0.9 billion last week, to 4.488 trillion.
M2 MONEY SUPPLY grew $43.5 billion last week.
MARCH 6, 2015
THE BLS EMPLOYMENT SITUATIONS REPORT blew away expectations with 295,000 net new jobs created in February. The unemployment rate fell further than expected, to 5.5%, which was influenced by a slight down tick in the labor force participation rate (i.e., some folks left the workforce altogether). Wages, after jumping .5% in January, budged just slightly---up .1%. While the naysayers will cite the lack of wage growth, make no mistake, this was a very robust jobs report that will surely change the narrative with regard to when the Fed will begin raising the fed funds rate. And I strongly suspect we're on the verge of a steady move higher in wages that will reflect in the reports to come.
THE U.S. TRADE DEFICIT narrowed in January, to $41.8 billion from $46.6 billion in December, on lower oil prices.
CONSUMER CREDIT rose $11.6 billion in January versus $17.9 billion in December. Unlike December, consumers did not tap their credit cards in a big way. While in December a jump in credit card usage was described as a signal of high consumer optimism, robust jobs growth and low gas prices are being credited for the consumer's lack of reason to turn to his/her credit cards in January...